LNG, Shale Gas and Politics in India

Basking in a Bangalore breeze, with a mango tree swaying outside the window, I am reminded of a fairly recent article concerning liquefied natural gas (LNG) imports into India. This story discussed a plan to import LNG from Qatar. There were a couple of points of note that are grist for this particular posting mill. First was the contemplated price of about $13 per mmBTU and the second was the mechanism for arriving at that price.

But first some background relative to Qatari motivation for long term deals such as this. The abundance of shale gas in the US has essentially taken that country out of the running as a Qatari LNG destination. Europe continues to be a valid target, but shale gas will likely be a factor there as well. Russia could well react to domestic shale gas in Poland and elsewhere with price drops. LNG may face lower prices but unlikely to see a US type debacle. Relatively close markets such as India shave 50 cents or more off a US delivered price. So, India could be important.

The truly curious aspect to the story cited is that the landed price is tagged to a Japanese crude oil basket price. For a few years now there has been a disconnect between oil and gas prices based on calorific value. Curiously, the more environmentally challenged one, oil, is currently priced at roughly three times gas price. That is commodity pricing. The disparity is even greater when one factors in refining costs. Transportation is something of a wash, although gas is cheaper to move than crude oil or refined products, at least on land. All of this is singularly premised upon the internal combustion engine being the workhorse of transportation.

Natural gas pricing is regional, largely due to the high cost of ocean transport. If local gas price is low, it is difficult for LNG to compete, which is why the US will be off limits unless demand takes a huge jump. Even then the abundance of the shale gas will likely keep the status quo. Local gas price in India was under $3 per mmBTU until recently. It is now $4.20, close to current prices in the US. That is the controlled price paid to domestic producers of gas. So, to contemplate imported gas at three times the price is the sort of action possible only in settings such as these: government control on commodity pricing. But pegging the price to an oil market basket, a Japanese one no less, is where logic takes flight.

Oil prices in coming years are likely to see sustained increases. Natural gas, on the other hand, will see a moderation in the US due to shale gas. If shale gas resources are found in other countries, one could expect similar pricing behavior. So, pegging any natural gas price, LNG or otherwise, to oil prices will result in a windfall for the producer and one that is not justified by supply and demand arguments.

Consequently, the main problem with the contemplated Qatari deal is not even the current high price. It is the possibility of up to a doubling in ten years. At anything close to that the incentive to use natural gas evaporates. Entire industries will shift offshore. It will be cheaper to make fertilizer, polypropylene and the like abroad and import the finished product. This will have a lasting negative impact on domestic jobs and the balance of trade.

An interesting subplot in the Qatari deal is the statement by them that they supplied cheap gas in India’s hour of need a few years ago. It was landed at $2.53 and has crept up to around $7 more recently based on whatever oil linked formula was used. The implication is that they should be rewarded now with a better deal. A fairly high fixed price would fit that scenario while still being unfair to domestic production. Pegging to oil defies logic and is simply bad business. The story is now four months old. Perhaps sanity prevailed. It nevertheless gave us an opportunity to discuss the underlying fallacies.

Shale Gas certainly has made an impact on the energy equation in the United States. As the article mentions, shale gas will likely be a factor in Europe as well.

ConocoPhillips is presently drilling and the results are highly anticipated, with activities to follow by Talisman and the Polish Oil and Gas Company (PGNiG). Natural Gas for Europe is updating all of the activities in this emerging area – http://www.shalegasforeurope.com

We need to know for sure whether there is a ceiling in the LNG pricing formula linked to Crude oil price. However wherever gas/LNG is replacing crude oil products, the comparative economics should not change even if LNG price is linked to Crude price without any ceiling.